Raising Equity / Capital
When a company raises equity, unlike when it raises debt, it is reported in the Cash Flow Statement as a cash inflow, and nothing ever shows up in the Income Statement. There is no interest expense incurred because the company is selling part of itself to outsiders. The process of raising equity sometimes is much complicated than raising debt.
For example, a group of investors initially owns 50% of the company. The company increases its equity by bringing in new investors. Shareholdings of the existing group thereafter will be decreased (or diluted). They may not be happy about this and might fight back if the company wants to increase its equity. They might also start making other demands on the company, such as certain financial targets or other “special favors.”
As business of our organic food store is very promising, we decide to pump $10,000 cash into the company with our own savings. As we pumped in 10,000 to the company, we have to record this transaction in the Cash flows from financing activities section.
| Cash Flow Statement | Year 1 | Year 2 |
| Cash flows from operating activities | ||
| Net Income | 28,804.00 | 51,034.00 |
| Depreciation | 0.00 | 6,000.00 |
| (Gains) / Losses on disposal of quoted shares | 0.00 | (1,000.00) |
| Changes in working capital | ||
| (Increase)/Decrease in Inventory | 0.00 | (22,000.00) |
| (Increase)/Decrease in Accounts Receivable | 0.00 | (45,000.00) |
| (Increase)/Decrease in Prepaid Expenses | 0.00 | (16,000.00) |
| Increase/(Decrease) in Accounts Payable | 0.00 | 4,000.00 |
| Increase/(Decrease) in Deferred Revenue | 0.00 | 11,500.00 |
| Net cash from operating activities | 28,804.00 | (11,466.00) |
| Cash flows from investing activities | ||
| Capital Expenditures | 0.00 | (18,000.00) |
| Acquisition of quoted shares | 0.00 | (10,000.00) |
| Disposal of quoted shares | 0.00 | 11,000.00 |
| Net cash from investing activities | 0.00 | (17,000.00) |
| Cash flows from financing activities | ||
| Proceeds from bank borrowings | 0.00 | 50,000.00 |
| Repayment of bank borrowings | 0.00 | (5,000.00) |
| Shares Issuance | 0.00 | 10,000.00 |
| Net Cash from financing activities | 0.00 | 55,000.00 |
| Net Change in Cash | 28,804.00 | 26,534.00 |
We must also reflect the transaction in our Balance Sheet as the new fund $10,000 will increase our Equity.
| Balance Sheet | Year 1 | Year 2 | Explanation |
|---|---|---|---|
| Assets | |||
| Current Assets | |||
| Cash | 30,000.00 | 56,534.00 | |
| Inventory | 0.00 | 22,000.00 | |
| Accounts Receivable | 0.00 | 45,000.00 | |
| Prepaid Expenses | 0.00 | 16,000.00 | |
| Short-Term Investments | 0.00 | 0.00 | |
| Total Current Assets | 30,000.00 | 139,534.00 | |
| Long Term Assets | |||
| Property, plant and equipment | 0.00 | 12,000.00 | |
| Total Long Term Assets | 0.00 | 12,000.00 | |
| Total Assets | 30,000.00 | 151,534.00 | |
| Liabilities & Equity | |||
| Current Liabilities | |||
| Accounts Payable | 0.00 | 4,000.00 | |
| Deferred Revenue | 0.00 | 11,500.00 | |
| Total Current Liabilities | 0.00 | 15,500.00 | |
| Long Term Liabilities | |||
| Borrowings | 0.00 | 45,000.00 | |
| Total Long Term Liabilities | 0.00 | 45,000.00 | |
| Toal Liabilities | 0.00 | 60,500.00 | |
| Equity | 30,000.00 | 91,034.00 | We also have to change the formula of calculating equity: [Year 2 Equity] = [Year 1 Equity] + [Net Income] + [Shares Issuance] 91,034.00 = 30,000.00 + 51,034.00 + 10,000.00 |
| Total Liabilities & Equity | 30,000.00 | 151,534.00 |
Impact of Raising Equity to the Financial Statements in a Glance
